Will Apple's New iPad Mini Be a Margin Killer?

Apple's has a bit of a problem on its hands. While the original iPad was introduced as a fairly high-margin way to disrupt the lower end of the PC market, it's really the iPad Mini that has been the star of the show over the last year. Indeed, while 10-inch tablet sales across the industry have been less than encouraging, the sales of tablets -- 7-8 inches -- have been robust. Unfortunately for Apple, this space is extremely price-sensitive, which means that even with a tablet priced at a healthy premium to its competitors' products, the iPad Mini is a device that sells below the corporate gross-margin profile.

However, there's another problem with today's iPad Mini. While it was a great device at launch, it was quickly outclassed by devices running Google's Android operating system. For example, the latest Nexus 7 comes packed with a 1920x1080 display, a fast Qualcomm processor, and a whopping 2GB of memory -- all starting at $229. The iPad Mini, with its outdated A5 chip, 512MB of memory and 1024x768 resolution display currently sells for $329. There's something seriously wrong with that picture.

A viable iPad Mini strategyIf today's fairly outdated iPad Mini sells for below Apple's corporate average, how well would an updated iPad Mini at that same price -- but with a more expensive processor, more memory, and a better display -- hold up on the margin front? Probably not all that well. So this leaves Apple in a very thorny situation. Does it go for volume and take yet another margin hit, or does it position the new iPad Mini as a higher-end device and try to fetch a premium for it?

While the first strategy would probably hurt Apple's margins substantially, and the second would likely kill sales, a third option is more likely: a bifurcated lineup. That is, update the internals of the old iPad Mini to about the level of the iPhone 5C but make the rest of it fairly inexpensive to manufacture, and then offer a higher-end tier of iPad Minis with all of the bells and whistles. That way, Apple can preserve its margins with the potential for upsell.

How can Apple compete with Google's Android tablets?The bigger issue is that the tablet market is increasingly shifting toward very cheap devices. When $150 will be able to buy consumers a very competent Google Android (but surely not Apple-quality) product, Apple's products become increasingly relegated to a high-end, but profitable, niche. Unlike the smartphone business, where the bulk of the device cost is actually subsidized by the cell phone carrier, these iPads and iPad Minis need to sell on their own at full retail. So, the real question is one of whether Apple will be able to meaningfully grow its profits here, which depends on getting the volume and gross margin dollar balance just right.

Apple: Not all is lost, but watch out for MicrosoftApple's greatest strength, aside from its excellent designs, is its ecosystem. Thanks to the popularity of the iPhone, consumers are very likely to be willing to pay a premium for the Apple ecosystem if they're satisfied. After all, why deal with having two different platforms with the need to purchase and download separate apps for each? The bet is that even at a hardware premium, the ecosystem will be enough to drive users in. That's not to say that Google hasn't done an excellent job building its ecosystem -- it most certainly has. There are many more Android devices out there today, and Android continues to get better each and every day, but there's still something special about iOS that people seem to love. Microsoft , too, has been actively trying to build out its ecosystem, although with less success thus far than Google.

Foolish bottom lineThe Oct. 22 launch of the new iPad devices will be interesting to see, and the initial sell-through of these devices will be a very interesting metric to watch. Can Apple regain share against the legion of Android tablets? Will the onslaught of Microsoft Windows 8.1-based tablets -- both large and small -- have a negative impact, particularly in the enterprise space? Only time will tell. But by the end of the year, investors should have a better idea of what the longer-term trends will look like.

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